High oil prices have a proven ability to rattle the Indian economy --- inflicting damage on public finances as well as putting the rupee under pressure.
So, the recent easing of global oil prices could give the Indian government some unexpected breathing space at a time when economic growth is weakening, inflation is persistently high, confidence is low and the currency is under pressure. Brent crude was trading at $111.82 a barrel on Monday afternoon, well below the recent peak of $125.28 that it touched in 16 March. Oil prices are slipping because of the growth slowdown in China as well as fears of another round of economic instability in Europe, say analysts.
The government assumes a certain level of oil prices when it draws out its annual budget, and especially when it estimates the fuel subsidy bill for the year. These assumptions can go for a toss, as finance minister Pranab Mukherjee saw in FY12.
The finance ministry has budgeted for Rs 23,640 crore of petroleum subsidies in FY12, but ended up spending Rs 68,481 crore --- one major reason for the massive fiscal slippage in that year. The root cause for this burgeoning subsidy bill: oil prices averaged $110 a barrel through the year while the budget makers had assumed prices at $90. (The oil prices the Indian government uses for its estimations are based on the so-called Indian basket, whose cost is usually a couple of dollars lower than Brent.) The budget for the current fiscal has been drawn up assuming average oil prices of $115 per barrel. The market price was higher in April, which is why the current plan to cap total subsidies at 2% of GDP seems a tough task. And that, in turn, puts the fiscal deficit target at risk.
Meanwhile, lower oil prices could take some pressure off the rupee, though funding a wide current account deficit at a time when capital inflows are erratic continues to be a huge problem. According to the latest available data from the commerce ministry, oil imports during FY12 were 46.88% higher than their value in the previous fiscal year --- at $155.64 billion versus $105.96 billion. Much of that increase is due to higher global oil prices.
The current decline in Brent crude prices could well be temporary. “There’s little to the latest price action than the increasingly self-fulfilling prophecy of ’sell it in May and go away’, with broader macroeconomic concerns used as a lightening rod,” Associated Press quoted a Barclays report as saying. “US oil demand is improving while Asian demand remains robust.”
Lower oil prices cannot help India beat its structural economic problems, but they could provide a beleaguered government with some breathing space. What it does with that space remains to be seen.
